Archive for December 2011

1. Conservatives tend to believe in market efficiency. They also believe that high inflation is just around the corner, because of the Fed’s “easy money” policy. But the TIPS markets don’t seem to agree. Conservatives often respond by pointing to the sharp rise in gold prices during recent years. Unfortunately, the increase in demand for gold is occurring in all the wrong places. Here’s a WSJ article on the skyrocketing demand for gold in Thailand:

There is a longer-term trend toward gold across the rest of Asia, too. The region now makes up around 58% of the global market for gold, according to statistics gathered by the World Gold Council, compared with 35% in 1970, while the combined demand from Europe and North America has fallen from 47% to 27% in the same period.

2. Tyler Cowen recently had this to say, in response to a commenter who argued that interest and dividends should receive the same tax treatment:

Contrary to common impression, the tax deductibility of interest payments does not give a tax advantage to borrowing, not if the return to savings is taxed.

That’s right, but of course it implies that dividends should also be tax deductible. And if they aren’t, there’s a good argument for making neither interest nor dividends deductible, but then lowering the corporate tax rate to make the reform revenue neutral. It seems odd that we are explicitly favoring debt over equity. What public policy goal does that advance?

3. Tyler Cowen wrote a New York Times column that commented on the large amounts of excess reserves in the banking system:

THE Fed’s stockpiled liquid reserves have met some heavy criticism. Hard-money advocates contend that they are a prelude to hyperinflation “” although market forecasts and bond yields don’t bear this out “” while proponents of monetary expansion have wished that banks would more actively lend out those reserves to stimulate the economy. That second view assumes that the financial crisis is essentially over, but maybe it’s not. As the euro zone crisis continues, it seems that Ben S. Bernanke has been a smarter central banker than we had realized.

I don’t know if the “proponents of monetary expansion” refers to market monetarists, but I’d be horrified if more than 10% of the excess reserves were to suddenly leave the banking system, as it could lead to excessive growth in NGDP and prices. I also have no desire to see banks “lend out” the reserves; I’d be happy to see them sell off a tiny percentage of their excess reserves. The last thing we should be encouraging right now is more bank lending. The issue of the optimal level of excess reserves is separate from the issue of where to set the IOR right now. We could get 6% NGDP growth next year with ERs of $200 billion or $2 trillion, it all depends on where the IOR is set, and hence what happens to the demand for ERs. Don’t confuse demand with quantity demanded. Tyler probably understands that distinction, but I’m sure many NYT readers do not.

4. For what it’s worth I think Krugman, Williamson, Noahopinion, DeLong, Andolfatto, and Lucas are all wrong. Lucas’s basic macro model treats changes in M and V as being equivalent. Sudden M*V shocks cause business cycles. That’s my view too. So although he said he was holding M constant, his comments make sense only if you hold M*V constant. In which case he expressed his reservation about fiscal stimulus in an exceedingly inept fashion, as that policy is based on the notion that government spending will boost M*V (perhaps by boosting V).

David Romer recently pointed out that the fiscal multiplier was roughly zero during the Great Moderation:

As Robert Solow stresses in his remarks in this session, we should not be trying to find “the” multiplier: the effects of fiscal policy are highly regime dependent. One critical issue is the monetary regime. Consider estimating the effects of fiscal policy over the period from, say, 1985 to 2005. Central banks were actively trying to offset other forces affecting the economy, and they had the tools to do so. Thus if they were successful, one would expect the estimated effects of fiscal policy to be close to zero.

My hunch is that Lucas understood this intuitively (multipliers had faded from view in recent decades) but at the moment he criticized Christina Romer he forgot why, as he hadn’t even thought about the issue for many years. That’s basically what DeLong said, except I have a different view of the model Lucas would defend if he had thought about it. I think it would have been my model of the near-zero multiplier.

5. Lots of people worry about persistent US current account deficits. But what if these deficits do not exist? If we are running current account deficits, then you’d expect the net outflow of investment income to be rising faster (indeed much faster) than the net inflow. Instead, Paul Krugman shows that the two series are quite closely correlated during normal times, and the US inflow lead has actually widened during the recent recession (when rates on our T-securities plunged.)

The US has a big saving problem. We save too little (due to multiple distortions in our tax and benefit systems.) But we don’t have a current account problem. “Unsustainable imbalances” can be sustained forever. Those who bet the other way will be disappointed.

Most influential-yet-obscure economic blogger:Scott Sumner. Be honest, how many people had even heard of Nominal GDP level targeting before this year? No one. But as the economy stagnated, and policymakers seemed increasingly incapable of mitigating the pain, many analysts started reading Sumner’s blog with interest. So far, the Federal Reserve has rejected his idea for NGDP target””under which the Fed would essentially target a combination of real output plus inflation rather than focus on curbing inflation alone””but the notion has attracted support from everyone from Paul Krugman to Tyler Cowen to Goldman Sachs. And much of that has to do with Sumner’s near-monomaniacal focus on the topic.

Klein presumably included the term “near” as a courtesy; I’m obsessively monomaniacal about NGDP.

Back around 2007 the US had lots of problems; income inequality, a rapidly declining home building sector, and according to some we were already well into The Great Stagnation. But one problem we didn’t have is high unemployment. Indeed unemployment was still only 4.9% in April 2008, by which time the great home building crash was already 70% over.

In the long run NGDP is of no importance at all; Japan’s NGDP is nearly 40 times larger than America’s. But sudden unexpected changes in NGDP matter a lot. Because nominal wages are sticky, a sudden downshift in NGDP growth will cause fewer hours worked and (except in Germany) a sudden upswing in the unemployment rate. More than enough reason for me to be monomaniacal about NGDP.

But there’s more, debt contracts are also denominated in nominal terms. During most recessions that’s not a big problem. However this time around there were two factors that made the NGDP downshift have a much bigger impact than usual. First, the decline in NGDP growth was unusually large. And second, both debtors and financial institutions were already greatly stressed by the sub-prime fiasco, even before the NGDP crash occurred. The NGDP crash then made the debt crisis much worse.

When I made this argument in early 2009 I don’t recall finding many takers. It seemed obvious that “the” debt problem was due to reckless practices of US banks and GSEs. But then the crisis spread out of the sub-prime ghetto and engulfed other types of real estate debt. Then municipal debt came under stress. And now we have the euro-debt crisis. Is it just a coincidence that all these separate debt crises flared up at about the same time? Is it just coincidence that they all occurred just after the biggest drop in NGDP since the Great Depression? Given that economic theory predicts that a sudden drop in NGDP growth will make it much harder to repay loans, my monomaniacal focus on NGDP doesn’t seem quite as crazy as in early 2009.

The Economist has an excellent new article on heterodox economics in the blogosphere. Lars Christensen should be proud; he created the name “market monetarist” just a few months ago, and now it has the official imprimatur of The Economist.

The article discusses three heterodox schools; neochartalism (MMT), market monetarism and Austrianism. The Economist is careful avoid any suggestion that the three are comparable in all respects:

These three schools of macroeconomic thought differ in their pedigree, in their beliefs, in their persuasiveness and in their prospects.

Market monetarism has recently been the most successful in garnering high level endorsements. The Austrian school has probably gained the greatest number of adherents (think about the Ron Paul phenomenon.) As for neo-chartalism, I always thought of them as being a bit wacky, and thus was surprised that Warren Mosler was cited more than any other individual, indeed 4 times as often as the Austrian representative (Lawrence White.) I might have reversed that ratio had I written the article. In any case, I see this article as a big win for both MMT and market monetarism, as Austrianism was already pretty well-established.

I don’t have any significant issues with the article, but will provide a slightly different take on a couple issues. Most of the market monetarism discussion focused on NGDP targeting, which of course is only one aspect of our model. But I think that was a wise move by The Economist, as you can’t possible explain all the theoretical nuances in a magazine article. And NGDP is where the attention is focused right now. Here’s their comment on the political feasibility of NGDP targeting:

The market monetarists argue that fiscal stimulus should be redundant, because a central bank can always revive spending””if it sets its mind to it. If the Fed’s efforts have disappointed, it is not because market monetarism is wrong, but because the Fed is not sufficiently committed to the cause.

This is probably true. But it makes it hard for the market monetarists to clinch their case. Until a central bank truly commits to their policy, they cannot prove their point. But until they prove their case, central banks will be reluctant to commit to their policy

As with almost all discussion of monetary policy these days, this mixes the issue of feasibility and desirability in a rather ambiguous fashion. NGDP targeting is actually not all that different from the Taylor Rule, or some other version of the Fed’s dual mandate. And Bernanke continually insists that the Fed doesn’t have to worry about running out of ammunition. So they can certainly boost NGDP if they want to. The question is; do they want to? Or perhaps I should say; is their desire to do so strong enough to overcome the perceived risks?

When I point this out to other economists they are inclined to smile politely, and say; “Well of course Bernanke would say that, imagine the market panic if he said they were out of ammunition.”

I point out that Bernanke held these views as an academic, when he had no reason to lie. Some argue that he changed his views after joining the Fed, for some mysterious unspecified reason. So although he’s always said the Fed never runs out of ammo, and he used to really believe it, now he’s lying. I have a two word response. Occam’s Razor.

Here The Economist exaggerates the amount of “activism” in market monetarism:

The market monetarists do not fret about the side effects of the activism they seek, which can misdirect capital, inflate bubbles and seduce people into over-borrowing.

I think they are confusing “activism” with “different policy.” We want the Fed to adopt a different policy, but the NGDP targeting regime would certainly be less “activist” than current policy, even if it didn’t involve the futures targeting regime that Woolsey and I have advocated. The current dual mandate/dual target approach allows for all sorts of activism. NGDP targeting has a single target, and would result in far less activism, and almost certainly far less of the bubble phenomena that are associated with dramatic changes in NGDP growth rates.

I know that Scott would insist he is not heterodox macro at all, but I can report I found it striking to be cited in this article as a more or less establishment source, rather than heterodox myself. In both cases the journalist is probably correct.

Because Tyler anticipated me making a mistake before I actually made it, I must of course try to frustrate his expectations. Here’s the reply I left in his comment section:

I was an orthodox economist in 2007, completely heterodox by early 2009, and am now becoming slightly more orthodox. Interestingly, my views haven’t changed at all during that 4 year span.

Seriously, Tyler has been the biggest factor in the success of my blog. I’m constantly getting invitations, and then am told that Tyler Cowen recommended they contact me. Next to Tyler, Ryan Avent has probably been the most helpful. Note that Ryan works for The Economist (although he’s probably not the author of this particular article) and also note the title of the article: “Marginal Revolutionaries.”

Krugman’s liquidity trap analysis is a blogosphere phenomenon; in the professional journals, it has little credence. One can make a good case that Scott Sumner, portrayed as heterodox in the article, is more mainstream than Krugman.

So Tyler, Arnold, and I offer 3 different perspectives, all of which are valid. There is no “fact of the matter.” (Just as there is no fact of the matter as to whether China is larger than the US, or whether the Ryan plan would abolish Medicare.) In response to a comment below, I replied:

I suspect there is no “orthodox” view of monetary economics, as many economists lack coherent views. The same economist might believe in liquidity traps, or not, depending on how the question is worded.

PS. Any thoughts on the artwork? At first I thought that was Bob Murphy chasing Krugman. But Bob’s not mentioned, and in any case he’s much more handsome than the cartoon character. I’m also not quite sure what to make of the Goya etching reference, which I believe is entitled something like “The sleep of reason produces nightmares.”

Update: Oh dear, I didn’t realize what I was getting into when I agreed to debate Bob Murphy.

PPS. Because of the holidays I won’t be able to catch up on comments for a few more days.

PPPS. I did see the story about the two Fed appointees, but have no comment because the press told us nothing about the only thing that matters—their views on monetary policy. A sad comment on our press, unless they don’t have any monetary policy views. In which case a sad comment on our political system.

Radio telescopes recently picked up this conversation, which seems to have come through a wormhole from a universe very much like our own:

What continues to amaze me is this: Japan’s current strategy of massive, unsustainable deficit spending in the hopes that this will somehow generate a self-sustained recovery is currently regarded as the orthodox, sensible thing to do – even though it can be justified only by exotic stories about multiple equilibria, the sort of thing you would imagine only a professor could believe. Meanwhile further steps on monetary policy – the sort of thing you would advocate if you believed in a more conventional, boring model, one in which the problem is simply a question of the savings-investment balance – are rejected as dangerously radical and unbecoming of a dignified economy.

Will somebody please explain this to me?

And then there was this reply:

Your mistake is to assume the monetary authorities will sabotage the fiscal stimulus, by failing to accommodate it with faster inflation. The fiscal stimulus will boost Japan’s inflation from 0% to 2%, and the BOJ will take over from there. What makes you think that the monetary policymakers will fail to sustain the faster growth in demand, once the fiscal stimulus has run its course?

And now I have an admission to make. The first message wasn’t actually from another universe, unless you consider Paul Krugman’s writings from 1999 to now be part of some alternative universe, produced by a quantum fluctuation in a Higgs energy field.

And the second passage is my pathetic attempt to imitate the views of my critics.

Tegmark argues that a level III multiverse does not contain more possibilities in the Hubble volume than a level I-II multiverse. In effect, all the different “worlds” created by “splits” in a level III multiverse with the same physical constants can be found in some Hubble volume in a level I multiverse. Tegmark writes that “The only difference between Level I and Level III is where your doppelgÃ¤ngers reside. In Level I they live elsewhere in good old three-dimensional space. In Level III they live on another quantum branch in infinite-dimensional Hilbert space.” Similarly, all level II bubble universes with different physical constants can in effect be found as “worlds” created by “splits” at the moment of spontaneous symmetry breaking in a level III multiverse.

I love how scientists can tell us that “nothing matters at all” in such technical language (“another quantum branch of infinite-dimensional Hilbert spaces.”) Don’t ya just hate it when everything happens?

And people think my zero fiscal multiplier is far-fetched. Multiverse theory implies that in another universe there is still a neoliberal Paul Krugman out there bashing fiscal stimulus, and a lonely blogger from the “University of Bentleys” vainly trying to resurrect Keynesian theory during a long dark age of new classical dogma. Krugman fancies the Foundation Trilogy, but Asimov had nothing on our modern scientists. As the post-modernists like to say; who needs science fiction when all of science is just storytelling?

A Merry Christmas to my readers as they veer off onto their nice and cozy alternative quantum branches.

Paul Krugman links to Jeff Madrick’s list of the 10 worst economic ideas of 2011. I don’t think much of the list, but I’ll just focus on one item:

Germany is especially proud that it has exported its way to becoming the strong man of Europe. It has suppressed wage growth, used subsidies to make its products more competitive, and taken advantage of the fixed euro, set at too low a rate to maintain trade balances. It is determined to remain oblivious to the fact that such a model requires countries that buy its products to run deficits and therefore borrow lots of money. This is why export models are known as beggar-thy-neighbor models, and it is why Germany has a moral obligation to help bail out nations like Greece, Italy, and Spain. Export models are really debt models on a global scale.

Madrick comes close to incorporating 10 economic misconceptions into one paragraph. Exports don’t make one strong, as the Japanese have shown. Subsidies don’t give one an advantage in trade. Nor does the level of the euro (except perhaps in the short run, but that doesn’t explain Germany.) Germany’s model doesn’t require other countries to run up lots of debt. It’s certainly not a beggar-thy-neighbor model, indeed I don’t think such a thing exists. Germany has no moral obligation to bail out the PIGS. Export models aren’t debt models. Even if every country in the world ran budget surpluses, places like Germany would still run trade surpluses. Here’s a quote from a new piece I wrote for The Economist:

It makes sense for a fast growing economy to borrow against the future, as when Korea ran deficits during the 1970s and 1980s. Or take a developed country like Australia. It absorbs a large flow of immigrants, who may borrow to buy a house against their future income within Australia. Indeed some current account deficits don’t even represent borrowing, at least in the ordinary sense of the term. Consider the case where Australians buy cars from East Asia, and pay for the cars by selling vacation condos on the Gold Coast to wealthy Asians. In many respects this is ordinary trade, except that the products that are built with Australian labour (the condos) never leave the country.

Australia hasn’t had a recession since 1991, despite running large current account deficits for that entire period. The Australian deficits are neither undesirable, nor unsustainable. Australia has lots of land, and Asia has a huge emerging middle class to buy condos located on that land. And Australia has almost no national debt. So why are trade deficits viewed as such a problem?

Australian national debt has recently risen to about 20% of GDP, whereas Germany’s is closer to 80%. Export powerhouse Japan is higher still.

The PIGS made several mistakes. One was excessive public debt (except perhaps Spain.) But Germany and America and Britain also have excessive public debt. The other mistake was in joining the euro. That combination proved deadly. But the euro isn’t responsible for Germany’s surplus; all the northern European countries (Switzerland/Germany/Netherlands/Denmark/Sweden/ Norway) have big surpluses, usually bigger than Germany in relative terms. Four of those six aren’t even in the euro.

In an article discussing House Speaker John Boehner’s performance in his job, the Post referred to his negotiations last summer with President Obama over, “the federal government’s swelling debt problem.” Newspapers interested in maintaining the separation between the news and opinion pages would have simple referred to the debate over raising the debt ceiling, which is what was at issue.

The debt has risen rapidly because of the recession that followed in the wake of the collapse of the housing bubble. Financial markets do not see the debt as a problem, which we know since they are willing to lend the government huge amounts of money at very low interest rates. There was no reason to interject this sort of editorial comment in a news story.

Here my disagreement (if that’s the right word) will be more subtle. I certainly agree that our big deficits don’t imply higher interest rates. Real rates are determined in global markets. But a large public debt can be a huge public policy problem even if rates are low. It means we must either stay in recession (to keep rates low), or recover, in which case the burden of the debt on taxpayers will suddenly become much higher. I’m “worried” that we won’t face that “worry.” I’m worried that we won’t recover, and that rates will stay low. So yes, the financial markets are predicting exactly what Baker says, but that’s extremely bad news.

[I’m not sure Baker disagrees, this is meant to be another spin, not a rebuttal.]

I also think there is a touch of naivete in Baker’s criticism of the press, although one could find 100 similar examples in my criticism of the press (so consider the following to be philosophical musing, not a critique of Baker.)

Baker also complains that the financial markets don’t fear deficits. Yes, and the financial markets tell us that the economy is not in a liquidity trap, every time they respond strongly to hints of Fed stimulus (QE2, etc.) But the press thinks we are. And we constantly hear the press talk about how the sub-prime crash caused the Great Recession, as if it’s an assumption so obvious there’s no reason to even justify it. Yet the financial markets (and the economic consensus) were not predicting a big recession as of mid-2008, even though the sub-prime fiasco was fully understood. There are all sorts of ways that the financial markets tell us we are wrong, but we pay little attention.

Yes, the WaPo blindly assumed debt is bad, but our press coverage is saturated with hidden assumptions about causality, and about morality. We talk about “unfavorable” trade balances, even though economic theory provides no reason to view surpluses as better or worse than deficits. We talk about “good inflation news” being lower inflation, even when the Fed is trying to raise inflation from excessively low levels. And except when the housing component of the CPI falls–then it’s “bad news.”

None of this should be any surprise, as humans tend shape their views of causality in a context saturated with notions of “good” and bad.” A few years ago I discussed a study by Joshua Knobe:

An experimental philosopher named Joshua Knobe reported some interesting findings in an interview on Bloggingheads.tv. (I believe this example is mentioned in his new book, Experimental Philosophy, but I am not sure. (And, no, the title is not an oxymoron.)) Knobe said that two groups of people were given two slightly different stories, and then asked a question. The first group heard a story where an engineer went to the CEO of a company with a project that he said would dramatically boost profits. But there was one drawback; it would seriously harm the environment. The CEO said “I don’t care about the environment, I only care about profits. Do the project.” For the second group, everything in the story was exactly the same except that project was said to actually help the environment. Again the CEO said “I don’t care about the environment, I only care about profits. Do the project.” In both cases the listener was asked whether the CEO intentionally hurt (or helped) the environment. Most people in the first group said the CEO did intentionally hurt the environment, but most in the second group said that he did not intentionally help the environment.

As I recall many commenters tried to justify this asymmetry, although I didn’t find any of their explanations to be at all convincing. Here’s what I think was going on. Readers immediately understood that their thinking about causality exhibited the same asymmetry as the people in Knobe’s study. Of course my readers tend to be much brighter and more logical than average. So they were outraged that I seemed to accuse them of “human tendencies,” whereas they saw themselves as being as strictly logical, like the character Spock in Star Trek. How dare you insinuate that I’m human!

Being a good economist is all about learning when one should think autistically, and when one should not. If I ever figure it out I’ll let you know.

PS. If you’re wondering whether the Australian case applies to the US, consider this:

Former Citigroup chairman Sandy Weill listed his 6,744-sq-ft apartment at 15 Central Park West for an astonishing $88 million in November, promising to donate the proceeds of the sale to charity.

Now comes news that Ekaterina Rybolovleva, the 22-year-old daughter of Russian billionaire Dmitriy Rybolovlev, is buying the condominium. Rybolovleva is currently studying at an undisclosed U.S. university and plans to stay in the apartment when visiting New York. According to a source familiar with the sale, she paid the full asking price of $88 million, setting a record for highest individual transaction in New York City history.

Here is the official statement from her representatives:

A company associated with Ekaterina Rybolovleva, daughter of a well-known businessman Dmitriy Rybolovlev, has signed a contract to purchase an apartment at 15 Central Park West, New York. The apartment is a condominium currently owned by the Sanford Weill Family.

Ms. Rybolovleva is currently studying at a US university. She plans to stay in the apartment when visiting New York. Ms. Rybolovleva was born in Russia, is a resident of Monaco and has resided in Monaco and Switzerland for the past 15 years.”

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Welcome to a new blog on the endlessly perplexing problem of monetary policy. You’ll quickly notice that I am not a natural blogger, yet I feel compelled by recent events to give it a shot. Read more...

Bio

My name is Scott Sumner and I have taught economics at Bentley University for the past 27 years. I earned a BA in economics at Wisconsin and a PhD at Chicago. My research has been in the field of monetary economics, particularly the role of the gold standard in the Great Depression. I had just begun research on the relationship between cultural values and neoliberal reforms, when I got pulled back into monetary economics by the current crisis.